We wake up to Futures appreciably higher, following last week’s 800 point blast off in the Dow, and higher bourses in Asia and Europe.

As we head into the last 4 weeks of the year, markets are flat since January 1st. Hedge funds are having a terrible time of it (See Breakeven is the new black).

Volatility for Q3 and Q4 has more than doubled versus Q1 and Q2.

The crosscurrents continue — it is a difficult environment to maintain any short positions in, as “the Interventionists” can goose the animal spirit, however temporarily the results are, at a moment’s notice. Traders are frustrated, investors are unhappy, the politics of the moment redefine the term rancor.

What was surely horrific news last week — a bank the approximate size of a Soc Gen — was on the ropes and about to take the long dirt nap. As the interventionists, well, intervened, that somehow became the basis of a massive rally. To prevent another collapse (the de rigeur phrase is “Lehman-like Event“) 6 central banks (plus China) agreed to a Coordinated Central Bank Intervention to provide liquidity and Dollar swaps facilities.

Its all part of the ongoing program Cash for Clunkers program begun under Bush and Paulson, continued by Obama and Geithner. The clunkers in this instance being zombie banks. We would all be better off in the long run if these mismanaged credit facilities were allowed to suffer the same ignominious fate of all poorly run enterprises in the Darwinian competition we call the economy: Reorganization and/or failure. Alas, that is a story for another time.

Today, we have a backdrop of improving retail sales (3-4%), modestly improving employment picture, and an uptick in consumer sentiment. Institutional investors so not have enough equity, are are desperate to move the needle higher before December 31st, a typically strong month for stocks. Offsetting that are earnings at a cyclical peak, negative income numbers, weak volume on rallies, a dysfunctional government, and an ongoing global deleveraging.

We must also make the near impossible probability calculation of when the next major banking disaster hits; it seems that we are a mere fat thumb or errant algo away from utter financial breakdown.

Hence, some caution is warranted. Last week, my client accounts were at 60-65% equity exposure. But on December 1, the tactical component of our portfolios flipped from 100% equity to 100% bonds. It might be bit early to become to defensive, as the year end rally shows no signs of letting up just yet. However, in secular bear markets, capital preservation and risk management should be every investors first priority.

Hence, Investors are advised to watch the quality of this rally — the volume, the market internals, the reaction to news events — and position themselves accordingly.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

Consider it a taste of the future: the fire, smoke, drought, dust, and heat that have made life unpleasant, if not dangerous, from Louisiana to Los Angeles. New records tell the tale: biggest wildfire ever recorded in Arizona (538,049 acres), biggest fire ever in New Mexico (156,600 acres), all-time worst fire year in Texas history (3,697,000 acres).

The fires were a function of drought. As of summer’s end, 2011 was the driest year in 117 years of record keeping for New Mexico, Texas, and Louisiana, and the second driest for Oklahoma. Those fires also resulted from record heat. It was the hottest summer ever recorded for New Mexico, Texas, Oklahoma, and Louisiana, as well as the hottest August ever for those states, plus Arizona and Colorado.

Virtually every city in the region experienced unprecedented temperatures, with Phoenix, as usual, leading the march toward unlivability. This past summer, the so-called Valley of the Sun set a new record of 33 days when the mercury reached a shoe-melting 110º F or higher. (The previous record of 32 days was set in 2007.)

And here’s the bad news in a nutshell: if you live in the Southwest or just about anywhere in the American West, you or your children and grandchildren could soon enough be facing the Age of Thirst, which may also prove to be the greatest water crisis in the history of civilization. No kidding.

It’s a Wonderful Life, central banks turn almost worthless PIIGS investments back into riskless investments and coerced 50%+ haircuts in Greek bonds are not credit events. Central banks been berry berry good to me.

Always need that end of year rally because you don’t want the sheeple worried about their pocket books during the holiday season. It will all turn back to sh*t in 2012. I don’t know if we’ll see the 600′s again but you can see that the intervention is getting less bang for the buck. Best thing these clowns can do is let things get back to the 700′s-800′s and then intervene – then you might have a 12-18 month rally. This intervene every couple months gimmick is going to blow up in their face.

Very valid comments and observations, and loss of homes, businesses is a tragedy.

That said, fire has always been a part of the earth’s ecology. In North America there is evidence of history of natural wildfires starting in Mexico and working all the way to what is now Canada. As a person with both personal and professional experience applying prescribed fire, it has benefits and is a natural part of the web of ecosystems.

Its all part of the ongoing program Cash for Clunkers program begun under Bush and Paulson, continued by Obama and Geithner. The clunkers in this instance being zombie banks. We would all be better off in the long run if these mismanaged credit facilities were allowed to suffer the same ignominious fate of all poorly run enterprises in the Darwinian competition we call the economy: Reorganization and/or failure. Alas, that is a story for another time.

reply:
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Are you a short who got caught holding at the time of rescue and are now outraged that the world was not put into a depression and massive asset sell-off due to massive liquidity withdrawals around the world … causing you to not make money as a result of your short position? Or are you just confused about the legitimate functions of a central bank … the ones that prevent world wide depressions due to liquidity failure.

For someone who has the capacity to present informed analysis and opinion about economics and monetary theory as applied by central banks (and their obvious failures in recent years), you seem totally ignorant of the one actual and legitimate function that all central banks were created to perform.

In times of massive liquidity crises due to bank runs (real or possibly manufactured to some degree), central banks send cash to banks in crisis so that withdrawals can be made. Without this power, assets would have to be sold to raise cash, and they would be sold at distressed prices. Like in 2008 – 2009. This is not a QE event. The incompetence of central banking would have been to NOT provide liquidity relief last week and allowed the world to end due to bond vigilante activities.

~~~

Are you a short who got caught holding at the time of rescue and are now outraged that the world was not put into a depression and massive asset sell-off? . . . Or are you just confused about the legitimate functions of a central bank?

BR: Not even close, and anytime you want to go head to head on long term or ST positions, I am game . . .

Nassim Taleb keeps saying that the longer “they” try to prevent another “Lehman-like Event“ (ie to “smooth out” the volatility) the greater the blow-up will be.
So there won’t be “another Lehman,” all-right, but what will happen one day (soon?) will be on a much grander scale. Something that won’t require “circuit breakers” on NYSE for 30min, but will result in a 1-week bank “holiday,” and/or 30-50% USD overnight devaluation, or overnight interest spike into double-digits on the 10yr.

Either we were way too pessimistic about a week ago or we’re way too optimistic today. There’s no alternative, since the only thing which has really happened in the meantime is the dollar swaps, and I haven’t seen any figures as to how much even it has actually been used. Everything else is just European politicians talking about what they’d like to do, but nothing’s been done yet.

Otherwise, it’s just the market being extremely bipolar, which given the leverage in banks around the world, and especially in Europe isn’t entirely crazy.

I do note that if MFS Global had managed to hang on for a week or two later they might have come out looking like heros. Hmmm- wonder how much impact they had by themselves on this whole volatility.

Biggest story is that we continue to pretend that all these derivatives have value – that you can issue a guarantee to pay off if your bet goes against you despite the fact that you lack to assets to make the payment, so long as you have received an offsetting guarantee from another party who likewise lacks the assets but in turn is dependent upon yet another party, etc.

The phrase “house of cards” is way too mild given the fact that there aren’t really all that many parties issuing these derivatives. Clearly the only reason everyone is OK with taking a 50% “haircut” (a misnomer if there ever was one) is that this way they can pretend that their derivatives are still worth something, rather than being worth zero. And then they can keep issuing more pieces of paper and booking “profits” from this activity.

It’s like a Ponzi scheme except that no one has ever even put any money into the scheme, just IOUs.

RE: “Volatility for Q3 and Q4 has more than doubled versus Q1 and Q2.”

My analysis indicates that the stock market volatility is one sign among many of rising risks. Although the stock market has had a strong advance over the last week or so (the S&P500 is now at 1252), I still believe that this is a very dangerous environment. For those interested, here is my last blog post on the subject:

BR: Not even close, and anytime you want to go head to head on long term or ST positions, I am game . . .

reply:
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You miss the point. By quite a lot. Investing is a personal endeavor. Nobody knows exactly what will happen in the future. All we have are clues and the education we bring to the party. I couldn’t care less about your calls. Personally, I think the market is heading up with significant volatility that should be very profitable over the next several months.

I was only lamenting about your ignorance about the function of central banking and how you apparently have difficulty differentiating between its legitimate function and prior incompetence.

The Fed and other central banks providing liquidity eliminated the risk of market crashes based on forced asset sales to raise cash. I have no doubt some financial criminals were betting substantially on an actual end of the world scenario and using massive hedge fund cash amounts to help it along. Conflating Greenspan’s idiocy with legitimate activities of central banks depreciates your comments and analysis of the entire topic.

However, if you would rather be followed by naive fanboys who gush over your insights, I would be happy to stop posting.

~~~

BR: So, you believe that the role of Central Banks should be to “provide liquidity in order to eliminate the risk of market crashes based on forced asset sales?”

I would love to see Barry and DH post an investment call on a company once per quarter — then backtest it at the end of each quarter. Given the oodles of experience and ideas both possess, I think this would make for some lively repartee. Make it long, short, options, whatever. Just do it!

~B-I-M

~~~

BR: I actually have a paper coming out in Q1 — that should give the quants some fun to play with.

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About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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